The company's inconspicuous office, located in a sparse new industrial park here in suburban Dallas, is no easier to find than it was last spring when the firm was located in another new corporate complex among the pines in Reston, Va.
But despite its size and humble digs, Digital Switch Corp. has, in its brief, five-year existence, attracted more attention on Wall Street and in the high-technology community than most companies of far greater size and stature. Although tiny Digital has yet to produce a single item for sale, its common stock has been promoted heavily. Last spring, Digital's price was pushed as high as $10.50 a share before settling to its current $6.50 on the over-the-counter market.
Why all the excitement?
Digital's overnight notoriety results from a number of related developments, not least of which is the company's claim that after five years of work it is nearly ready to manufacture a high-speed, compact electronic device for routing telephone calls. Indeed, backers and company officials alike claim that the switching gizmo will be several large leaps beyond anything currently on the market -- and the investors apparently believe it.
But what really put Digital on the map was when, on the basis of a promise, the company raised $8.5 million in capital last year by selling securities to the public. The stock offering was handled by John Muir & Co., which was then also a small operation but soon became the hottest new issue brokerage on Wall Street.
Under the direction of Muir's irrepressible general partner, Raymond L. Dirks, the firm's team of high-pressure salesmen peddled shares of Digital to customers on the basis that it was a company on the frontier of the telephone revolution.
It turns out that the development of Digital's switch has been more evolutionary than revolutionary. At any rate, Muir won't be around to see any switch Digital might finally produce.
In August, beset by lawsuits from angry customers, investigations by the Securities and Exchange Commission and defections by its sales staff, Muir declared bankruptcy. The brokerage firm is in liquidation.
But the Digital Switch story continues to unfold. The roles played by the promoters and financiers in the company's struggle for survival is a classic example of the rough-and-tumble world of new corporate ventures.
When it went public, Digital had no product, no management, not even the most rudimentary accounting system. An SEC suit naming some of the founder-promoters (who are no longer with the company) was settled with the parties neither admitting or denying the allegations, and agreeing to take remedial action. Digital disclosed to investors that a $5 investment in a unit -- a share of common stock plus a warrant to buy another -- actually was worth less than one cent, according to two separate appraisers. In short, as that valuation in Digital's prospectus indicates, the promoters' claim that "significant orders" for the switch were coming "in the near future" was just hot air.
If Digital's new and respected management does finally produce the switch and the company manages to sell it to major communications companies, then the investors who shot craps and bought the stock will probably make some money -- maybe even a lot of money. However, the really big money will be made by a very few individuals who for any number of complex and fascinating reasons are riding the inside track on the development of Digital's switch.
Like so many high-tech companies, Digital Switch was formed in 1976 by a couple of engineers who learned their trade with another technology company. John S. Edwards and Theron M. Randall had worked for Data Transmission Co. (Datran) in Vienna, Va., and when that company went under, they joined forces to form Digital Switch in McLean. They set out to design and build a telephone switching system that would use "state-of-the-art digital technology" for handling and billing telephone calls. As they envisioned it, the system would be faster, smaller and more flexible that anything then on the market.
But the engineers needed financing; enter two Washington-area stockbrokers, Harry E. Hagerty Jr. and Charles W. Marmon, who became Digital's executive vice president and chairman of the board, respectively. Between 1976 and 1979, the two brokers began selling stock privately to raise funds for the engineers.
The brokers and the engineers split in 1978 when the brokers proposed selling stock in the company to the public.
"We wanted to keep it private," Edwards recalls. But the engineers lost in a proxy fight to the brokers and the private investors. The engineers quit and took their ideas for the revolutionary switching system to the subsidiary of a French firm based in suburban Washington. But the French firm soon collapsed its U.S. operations. Randall now works for the company in France, while Edwards, who says he still has only a "piddling" amount of Digital stock, now operates a consulting firm in McLean called Digicom. The brokers, meanwhile, found that their plan to sell Digital stock to the public proved to be their undoing.
In April 1980, the SEC filed suit accusing the two brokers of securities fraud for selling unregistered securities. The suit came about after Hagerty and Marmon decided to make a public sale of the stock through John Muir & Co., where Hagerty was a registered representative in the Washington office.
According to the SEC, Hagerty had never informed Muir that he was an officer of Digital or that he had already been selling Digital stock privately. Indeed, the SEC complaint alleged that the two brokers failed to record stock sales properly, leaving questions about exactly how much of the company had been sold.
As for Marmon, the suit marked his second scrape with the SEC, which had barred him in 1973 for three years from being a principal in a securities firm.
In August 1979 a new face appeared in Digital's office. Reynolds Sachs, now 41, with a Ph.D. in economics from Columbia University and a law degree from Georgetown, took on the job of shaping up Digital preparatory to the public stock offering. Among the first things he did was to bring in the accounting firm of Arthur Andersen to set straight the company's chaotic books.
Sachs, who was named chief executive officer, made it a condition of his employment that Hagerty and Marmon be purged. He also negotiated a handsome compensation package for himself -- which, like salaries of the firm's other officers, is being paid out of stock revenues and loans since the company has no sales or profits.
When Sachs joined the company, he contracted to get a minimum salary annually of $125,000 which rises to $145,000 this year, then to $175,000 for the last three years of the contract through 1986. He also paid a penny a share for 390,000 shares of Digital stock, which if Digital clicks, will make him a fortune.
But Sachs faced serious problems in late 1979. The engineers were gone, leaving the undeveloped switch behind. To hire new engineering talent he needed financing, but because of the questionable financial deals of the former management, the SEC was taking its time reviewing the registration for selling stock to the public. Sachs needed cash to tide the company over until the SEC freed Muir to sell stock to the public.
As he recalls what happened next, Sachs was in Harry's bar one day in the ground floor of the American Stock Exchange worrying aloud about how he would make the next payroll at Digital. "Somebody at the bar introduced me to Edward Crooks, a specialist on the floor of the exchange," he says.
Crooks listened to his story about the switch, then left to make a phone call. When he came back he told Sachs to take a cab uptown to 711 Fifth Ave., the home of Allen & Co., the investment banking house where Crooks' cousin, Richard, was a vice president.
Within 10 days, Allen had lent Digital $50,000, with a promise of another $150,000 once the SEC passed on the new stock offering.
Finally, in August 1980, the SEC cleared the Digital prospectus to sell 1.7 million units at $5 each. One broker described the prospectus, which disclosed to investors the little company's checkered past and chancy future, as "the nastiest document I've ever seen." Still, the stock was well received by investors, thanks mainly to Muir's aggressive sales techniques.
What's more, investors weren't the only ones eyeing the company. As early as 1976, the word got out in the industry that a couple of engineers were seeking to develop a new telephone switch. Among those fascinated were James L. Donald, 50, and James M. Nolan, 47, who at the time were president and chairman, respectively, of Danray Inc., which is located in Richardson. After the Canadian conglomerate Northern Telecom Ltd. acquired Danray, the two men decided they wanted to run their own company again, according to Donald.
Donald and Nolan joined Digital in March 1981. Soon after, several talented engineers from Danray, which Digital desperately needed, followed the two executives. Says Donald: "It's almost as if on March 15 we started a new venture, and we're going hell-bent for leather to make a dream come true."
First thing they did was to move the company from its temporary home in Reston to Texas, where engineering talent is plentiful, corporate and personal taxes are nonexistent and unions are weak.
Donald got a pay-bonus contract similar to Sachs', and Nolan got a generous piece of the action. Nolan became chairman, Donald president and chief executive and Sachs, who decided to stay in the Washington area, is vice chairman.
According to the prospectus, Sachs, with 11.3 percent, is the company's biggest stockholder. Allen & Co. now owns about 10 percent of Digital's stock and is represented on the board of directors. Another major lender, Atlanta Investment Co. Inc. of New York, has 6.6 percent, and Floyd R. Resley, owner and president of Resley Tire Co. Inc. of Hagerstown, Md., has 2.5 percent. Donald owns 4.4 percent of Digital, which he bought with a 10 percent-interest loan made by the company.
As for the fact that Digital is still without a product, Donald says the company is on schedule and will be marketing a switch by early 1982. The competitors already in the market include Stromberg-Carlson, ITT, TRW and Donald's old employer, Northern Telecom. Donald says he is seeking customers among the specialized common-carrier companies, the private systems and the independent telephone companies.
Last spring, the company announced it had an order for $21.7 million worth of switching equipment. But until now, Donald had refused to disclose the company's name, at their request, he says.
The buyer, however, was named last month in a filing made by Digital with the SEC, a fact that caught Donald by surprise.
The company is U.S. Telephone Communications Inc. in Dallas, a privately owned firm, and the filing makes it clear that the contract is far from firm. Among other things, Digital discloses "uncertainties" about its own ability to produce the switch for the contract while U.S. Tel, for its part, may not be able to finance it.
In short, Digital Switch, after five years of work and millions of dollars of investor capital, remains very much a gamble.